China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

"The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation," said Charlene Chu, the agency's senior director in Beijing.

"There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signaling," she told The Daily Telegraph.

Evans-Pritchard goes on:

Fitch warned that wealth products worth $2 trillion of lending are in reality a "hidden second balance sheet" for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

(...) The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990.

(...) "There is no way they can grow out of their asset problems as they did in the past. We think this will be very different from the banking crisis in the late 1990s. With credit at 200pc of GDP, the numerator is growing twice as fast as the denominator. You can't grow out of that."

Meanwhile, interbank lending is tightening fast. Over the last 10 days, the overnight rate of the SHIBOR has jumped from around 6% to over 13% today, and the 1-week rate has gone from 5% to 11%.

There are folks here who can interpret this better than I can. Is this a lot of fuss about nothing, or at least something China can handle?

The PRC could re-discover its Marxist roots - except, almost certainly, the families governing the PRC comprise a high percentage of the holders of the WMPs. They will probably try creating TITFFs, To Important To Fail Families. Those not strongly connected are likely to find out just how effective are their financial shelters - as that will be all that remain to them.

WMP holders should mostly be the common folks. In "Marxist" countries, workers are forced to be big savers, especially in China with its one child policy. The government basically gets deeper into debt to its own population - with a power of monopolist debtor though. The Chinese Party "enterprenuers" benefited very handsomely from cheap borrowing (at negative rates, essentially). Their profits are priveleged to be saved by various means. Options are different for the wide population.

Incorrect phrasing on my part. Instead of 'holders of the WMPs' I should have said 'originators', although low level members of the CPC may be 'investors'. Do you have knowledge of the current structure and extent of the CPC. Do they currently aspire to have a large portion of the population as members? Are there junior branches like the old Komsomol with little power within the party but important for spreading the word?

I imagine things are more openly inheritable in China now. But the country still needs mass of talented, well educated technocrats to keep the stories of improving living standards an economy performance viable beyond all challenges.

One of the ways that the party has been able to keep control over the country has been to allow liberalization while the old party elites retain control over assets. Yesterdays communists become today's capitalist elite. Dynastic cycle complete.......

Moreover, one of the secrets of the Chinese "miracle" has been that most of the reflationary spending since 2008 has come from local, rather than the national, government. The principle source of income for local governments in China? Land sales......

This all comes at the same time as massive wage inflation is hitting. Wages in Guangdong have nearly doubled since 2009......

The knock on effects of this are disastrous not only for China, but for the developing world. Without Chinese demand, commodity prices are going to collapse. Look at what happened to oil prices during the 1997-1998 Asian economic crises.... If this happens again, the good times in Africa are going to be coming to a close.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

Central government spending is divided into two parts: central-level expenditures (中央本级支出), which includes spending by central government ministries and bureaus; and transfer payments/tax refunds (税收返还和转移支付), which includes money reallocated from the central to the provincial authorities (transferred-down payments). For years, the latter has been the dominant part of overall spending. In 2013, money reallocated to provincial authorities accounted for 70.2% of the total budget....

This fiscal arrangement traces its root to the 1994 tax reform, the most monumental fiscal reform of the last 30 years. In the 1980s and early 1990s, tax collection was delegated to local governments, who kept most of the revenues at the local level. Although this system motivated local governments to catalyze regional economic development, it severely weakened the financial capacity of the central government and skewed the balance of power between central and local authorities. In 1994, the central government enacted a radically new policy, requiring that most taxes be collected and kept at the central level. The central government then distributed the revenues to provincial authorities to cover their expenses. In 2012, the transferred-down payments made up 42.6% of all of the revenue of local governments. The post-1994 system engendered made local governments financially dependent on the central government, and turned the tables in the balance of power, as reflected in the previous chart.

So over two thirds of the central government budget is administered at the local level, but those transfers make up only about half of local budgets. The other half comes from land sales.

China's use of land sales to fund local governments is no longer on such solid ground, according to a top legislator....

"It's getting so bad that if (local governments) don't sell land, they can't even pay salaries," said Mr. Li, a member of the legislature's Standing Committee, a grouping of its senior members.

"How long can this `land fiscal policy' last? Another five years?" he moaned in front of an audience at a financial forum.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

That said, if I think of an example familiar to me: if a city builds a metro system by combining transferred-down funds from the central government's stimulation programme and its own income on land sales, a bursting bubble for the latter can kill the project even if the central government continue to offer the money.

Anything prior to 2009 it is very hard to get accurate statistics on. Detailed budget reports only date from that year on, and it's still rather vague. The reflationary spending has primarily been directed to infrastructure and attempts to stimulate domestic demand.

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

The 'land sale' method of civic finance can only be a stopgap. It reminds me of the use of 'assignats', or 'assignments' of confiscated church lands during the French Revolution. Sure, The Church held the prime third of all agricultural land in France, but it was transferred relatively quickly to new owners. In China it is a process of local CPC officials identifying land that can profitably be redeveloped and simply confiscating it from powerless owners. But the people to whom the land is transferred are far from powerless, so there will be an endpoint to this process relatively quickly, which is what Li is saying.

On the bright side the Chinese economy still has huge state owned enterprises that are significant operators and it still has over $1 trillion in foreign reserves. Perhaps we have found the perfect place to apply the US new classical principle that debts don't matter as they just represent changes in who owns what and who owes what to whom. The Chinese could largely settle this amongst themselves.

Been doing some research and things are not rosy in the Wealth Management business. I was under the impression US Venture Capitalists had their stuff together. For the top firms, that's true. For the majority of firms, not so much.

In May 2012 the Kauffman Foundation released a study on actual market performance of Venture Capital Funds. The report, We Have Met the Enemy ... And He is Us, "a comprehensive analysis of the Kauffman Foundation's more than 20 years of experience investing in nearly 100 VC funds." The finding isn't pretty:

... the Limited Partner investment model is broken.

and Kauffman would have done better to invest their money in the Russell 2000 index of small-cap stocks.

Several reasons for this, the most important one is the General Partners (GP) of the fund are in the business of raising money and collecting management fees. How well a GP manages the investments isn't in the picture.

Which is weird but there it is.

I doubt the average Chinese wealth manager is any better than their American counterpart. Lemming-like behavior is a well known property of the US investment markets thus I am confident it's a property of the PRC's investment markets too. Some proof lies in the reports China has entire cities with houses, apartments, stores, etc. 100% purchased, as an "investment," and ~100% unpopulated.

This diary also provides a bit of evidence for something I've been thinking for some time: the world is awash in cash, most of it deployed and/or locked into economically useless fol-de-rol.

If so, cannot one start to seriously question, and examine, the Pop idea:

cash = wealth

?

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

The fundamental reason why money is tight is that Beijing is now starting to let the economy adjust. Then Premier Wen Jiabao did not allow adjustments when the global downturn hit China in 2008. His successor, the newly installed Li Keqiang, is starting this critical task. "Their choice is not whether to tighten or not, but when to tighten," says Zhang Zhiwei of Nomura. "The earlier they act, the lower the cost. If they waited longer, there would be more bad loans to deal with."

The oft-quoted Zhang makes it sound as if China is starting early. The new premier, to his credit, is starting in the first days of his tenure as premier, but Beijing should have begun tightening long before he was formally installed in March.

The primary constraint Premier Li faces is China's massive debt. Total credit looks like it reached an incredible 198% of GDP by the end of last year. By 2015, that number will hit 245%, according to Francis Cheung of leading brokerage CLSA Securities. Fitch Ratings has just sounded an extraordinary warning on China's credit creation.

Li Keqiang has few options, and none of them are good. True, he can avoid a day of reckoning by just continuing the lax monetary policy. That course, however, aggravates the underlying debt problem by keeping money cheap and thereby permitting even more bad investment decisions. China has long passed the point of diminishing returns when it comes to debt. In 2007, Wen Jiabao created 83 cents of gross domestic product for every dollar of credit he authorized. Today, Premier Li gets just 17 cents of output for every dollar.

Bank of China Ltd. (3988) announced on its microblog that it made all payments on time today and has never had a capital default. A spokesman for Industrial & Commercial Bank of China Ltd. (601398) declined to comment on whether the lender received any financing from the central bank.

Maturing notes added a net 28 billion yuan to the financial system this week, down from 92 billion yuan last week. Chinese banks need to step up efforts to support economic reforms and do more to contain financial risks, the central government said yesterday after a meeting led by Premier Li Keqiang.

"The market's move is not just because of liquidity but due to a policy stance that won't change," said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd. (ANZ) "After Li's statement yesterday, the market now sees the crunch lasting longer. Until after mid-July, liquidity won't get better significantly."

The popular explanation for the rise in Chinese repo rates is being linked to the government's desire to rein in the shadow banking sector. That is to say the tightness is intentional.

But what if it isn't. What if it has more to do with the unwind of yet another carry trade?

Deutsche Bank's Bilal Hafeez made a strong case for this interpretation last week. We think it's worth revisiting the argument.

There are three main factors that need to be considered, he argued:

Adjusted for volatility China now offers the highest FX carry in the world. This, he says, has led to a surge in flows into the CNY (and CNH) by both onshore and offshore entities over the last few years.

The performance of the carry was reaching breaking point last week.

Any combination of higher US yields, regulatory clampdown or higher FX volatility or CNY appreciation could trigger an unwind.

And as he warned, the demise of the carry trade would then remove an important channel of cheap funding for the Chinese economy.

the demise of the carry trade would then remove an important channel of cheap funding for the Chinese economy.

Too bad they cannot sell that empty city or the empty shopping malls. Mal-investment is painful. Actually, they probably could get some value unlocked from that mal-investment, but it would involve harm to powerful people, just as in the USA.

Yao says the answer to where the money is going is a growing "debt snowball" which doesn't contribute to economic activity. The result is both companies and the public sector face burgeoning interest expenses.

This fits with the theory first put forward by economist Hyman Minsky of Washington University in St. Louis. His financial instability hypothesis showed how markets create waves of credit expansion and asset inflation, followed by periods of contraction and deflation.

Using methodology from the Bank for International Settlements, Yao estimated a debt burden of non-financial companies and local government financing vehicles of about 150 percent of GDP at the end of 2012. Assuming an average interest rate of 6.3 percent, Yao estimates a "shockingly high" debt service ratio of 338.6 percent of GDP.

Similar ratios were evident in countries as they neared financial and economic crises, including the U.S. and the U.K. in 2009, South Korea in 1997 and Finland in the early 1990s.

"The logical conclusion has to be that a non-negligible share of the corporate sector is not able to repay either principal or interest, which qualifies as Ponzi financing in a Minsky framework," said Yao. "This is one more data point in China that evokes the troubling thought of a hard landing."

Unlike other credit crunches (e.g. that in Italy now), this particular credit crunch was effected by the Chinese government for the purpose of pricking the gigantic speculative bubble in China before it inflates further with devastating potential. This same bubble is intimately linked to the US economy: both US finance and the midwest mining areas of the US are fully involved. Shortly afterwards Chairman Bernanke started talking about relaxing QE3. If the Chinese government no longer wants to provide unlimited liquidity then the whole burden of sustaining the bubble would fall on the Fed. Mr Bernanke considers this to be far too dangerous and for this reason he may have brought forward the Fed's exit from QE. In this reading, the Fed's signal that it is exiting QE has nothingto do with the actual health of the US economy and everything to do with China's economic situation and government intentions. Bernanke seems determined to reduce QE for reasons that have to do with China.

--- is the first analysis I have seen that makes real sense of Bernanke's recent actions.

...Europe's elites failed to recognise, both before and after 2008, that their precious Eurozone was predicated upon the United States' capacity to recycle global surpluses, including of course Europe's surpluses. Lacking its own effective surplus recycling mechanism, Europe became unhinged shortly after the Fall of 2008, remains in denial to this day and, as a consequence, is wedded to policies that are either irrelevant to the nature of the Euro Crisis or impossible to implement in the new, post-2008 world.

(...) To see why America has lost its capacity to recycle other nations' net exports at the pre-2008 pace, it suffices to note that in 2011 the United States was generating 23.7% less demand for the Rest of the World's net exports than it would have been without the Crash of 2008. Secondly, and at the same time, America was failing to attract (through Wall Street) the level of capital flows which would be necessary to maintain the pre-2008 pace of investment into its private sector. To be precise, by 2011 the United States had lost 56.48% of the assets held by foreigners compared to the (trend) level that would have been held had the Crash of 2008 not happened. The main, and indeed crucial, reason for this precipitous decline was that foreign net capital flows ending up as loans to US corporations fell drastically from around $500 billion in 2006 to -$50 billion in 2011.

By 2013 these trends have crystallised into a devastatingly simple picture: On the one hand, the Crisis did not alter the deficit position of the United States. The federal budget deficit more or less doubled while America's trade deficit, after an initial fall, stabilised at the same level as before. However, the US deficits are no longer capable of maintaining the mechanism that keeps the global flows of goods and profits balanced at a planetary level. Whereas until 2008 America was able to draw into the country mountains of net imports of goods, and a similar volume of capital flows (so that the two balanced out), this is no longer happening post-2008. American markets are sucking 24% fewer net imports (thus generating only 66% of the demand that the Rest of the World was used to before the Crash of 2008) and are attracting into the American private sector 57% less capital than they would have had Wall Street not collapsed in 2008.

In short, the only reminders that remain of the kind of global economy in which the Eurozone flourished prior to 2008 are the still accelerating flows of foreign capital into America's public debt, evidence that the world is in disarray and, in this age of tumult, money is desperately seeking safe haven in the bosom of the reserve currency. But as long as the Rest of the World is reducing its injection of capital into America's corporate sector and real estate, while America is reducing its imports of their net exports, we can be certain that the Eurozone cannot rely on the United States to provide, as it did before 2008, the level of aggregate demand that is necessary in order to maintain the mercantilist daydream of a Germanic Europe; i.e. of a Eurozone that behaves as a Greater Germany, reacting to drops in global demand by boosting its overall net exports while, internally, squeezing real wages.

If, as Y.V.'s correspondent above asserts, the Chinese bubble has major effects on US policy, I have a job seeing that as a sideshow.

For many years, critics of China who identify with this mythical phoenix like creature called `the markets' have been telling China that it needs to do something about its debt problem. Eventually Beijing, says `Oh, OK' and deliberately stages - not allows to happen, but deliberately stages - a Lehman event across its banking system. This was not a response to a crisis: the PBOC could have pumped more money into the system this time just as it had done before. It's an act of will.

And `the markets' promptly crap themselves, though I don't know if this is actually serious or that `granny just saw a flasher' response that you seem to get a lot of. Actually, what the folk on the trading desks have been exposed to is something that people in China have known for a long time: this is how China solves its problems, with brutal and ruthless fixes. Ok, we have a problem. We also have absolute power. HULK SMASH. Think of this as being in the tradition of the One Child Policy.

This approach is sometimes characterised as Maoism, but it's really Dengism; the adaptation of all the tools in the Leninist box away from ideological mobilization and towards real world problems. Who cares whether the cat is black or white so long as it's a fucking huge apex predator?

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

One culprit: The People's Bank of China is showing that it's very disinclined to step in and smoothe over tight liquidity conditions.

Instead it's telling the banks to deal with their own mess.

Nomura's Zhiwei Zhang passes allong the message from the PBOC in a brief note

The guidance note stated that "overall bank liquidity conditions are at a reasonable level" and asked banks to "prudently manage liquidity risks that have resulted from rapid credit expansion", "appropriately contain the pace of loans and bill financing" and "utilize the stock of money and credit to support the economy". We believe these statements suggest that the central bank's policy stance remains tight. The decision to put this note on its website suggests the PBoC wants to reiterate its policy stance.

At the moment, the most likely end game of all of this is more realisation of misdirected investments that have resulted from the vast wave of credit growth over the past few years (which has in turn taken the place of export growth as China's primary key of growth).

Recognising the misallocation -- or being forced to recognise it -- would in turn imply a steeper growth slowdown. Just look at how the sub-8 per cent growth has shaken global confidence. Nomura are now putting a 30 per cent chance of sub-7 per cent growth in H2.